Selecting a Tactical ETF Manager: Six Items to Research

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By Joseph Hosler

The number of tactical ETF Strategists has increased since the 2008 Financial Crisis as advisers look for managers able to navigate uncertain market conditions.

According to Morningstar, as of the end of the first quarter of 2016, there were 156 ETF strategists managing $76 billion in client assets. Over 67% are characterized generically as tactical managers. As the market for ETFs grows, so does the demand for tactical managers, and the need for a system by which to evaluate managers grows.

Below we offer six factors that should be considered when assessing a tactical manager.

1. Live and Backtested Performance:

When evaluating a tactical manager, compare the manager’s live performance track record to their hypothetical backtest results. This will help assess the efficacy of a manager’s philosophy and process. Backtests are often ridden with errors, but they do offer a glimpse into the rigor and durability of a manager’s strategies. If the manager’s live track record does not demonstrate similar values to those predicted by the back tests, it may suggest that the manager is still attempting to solve the last problem that the market encountered rather than focusing on the next one.

2. Riskiest Portfolio:

A tactical portfolio manager will reconstitute his portfolio over time, attempting to best navigate the market’s waters. This will lessen the value gleaned from metrics of skill based on averages, like Sharpe ratios. We believe average-based skill metrics only tell part of the manager’s story. You should have an idea of what a manager’s riskiest portfolio looks like and make sure you are comfortable using that portfolio for your clients in any environment. An improved understanding of a manager’s riskiest portfolio will help you understand the risk you take on if the manager’s algorithms fail to accurately capture the market.


3. Batting Average in Both Up and Down Markets:

What are you looking for in a manager? If you’re looking for aggressive upside in good markets or protection in down markets, the importance of assessing a manager’s skill in these regimes is imperative. As part of this evaluation, you should check that a manager’s historical returns match the desired application by calculating their batting average. A batting average looks at a manager’s ability to outperform the benchmark but does not evaluate by how much the manager outperforms; it only takes into account the number of months the manager beat the benchmark in rising and falling markets. If the manager is focused on downside protection but has a poor batting average in down markets, you may need to dig deeper into the validity of their strategies.

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